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If China sharply raised the exchange value of its currency against the US dollar as so many US leaders now demand — what will happen? As always in such questions about the future, no one knows. That is because no one can foresee all the changes in all the social processes that will combine to determine — “overdetermine” is actually the better word — the consequences for the world economy that will flow from a cheaper dollar vis-à-vis the yuan. However, several of the possible outcomes should make US leaders worry lest they get what they are wishing for and demanding from China’s leaders.
First, were China to increase the value of its currency against the dollar, the consequent drop in yuan-denominated prices of US assets could unleash an avalanche of Chinese purchases of those assets. Then we would see the reverse of what happened in the aftermath of the 1997 Asian currencies crisis when assets of the affected countries were bought by foreigners — including especially US buyers — in huge quantities. One is entitled to wonder how US leaders would explain to the US public the surge in Chinese purchases — and thus Chinese employers of US workers — as a consequence of those same leaders’ currency revaluation demands.
Second, success in pressuring China to increase the relative value of its currency would likely extend the same demand to Japan. The combined revaluation of Chinese and possibly also Japanese currencies would place immense pressures on both countries’ central banks to slow or stop accumulating dollar-denominated reserves and quite possibly to reduce their holdings of US debt. There would be two immediate reasons for those banks to act. First, the reduced value of the dollar relative to the yuan and perhaps the yen would entice Chinese and Japanese companies to buy dollars in order to purchase the suddenly cheapened US assets. Their own central banks would sell US treasuries, etc. to raise those dollars which they would then provide to their national companies — in exchange for those companies’ yuan or yen — to enable their purchases of productive assets in the US. The second reason why banks would dump US treasuries and other dollar-denominated debt instruments is to lessen the negative impact of a falling dollar on their official reserves (now held chiefly in dollar forms). In short, the current diversification of Chinese and Japanese reserve holdings out of dollars and into Euros, pounds, Swiss francs, etc. would accelerate. Official Chinese and Japanese sales of dollar-denominated US debt would drive down the prices of such debt and hence raise interest rates inside the US with the predictable contractionary impact on the US economy.
Third, a rising Chinese currency would cheapen the costs of many of China’s imports. To the extent that those cheaper imports mean lower input costs for Chinese producers (lower costs for tools, equipment, and raw materials, but also lower costs for Chinese workers’ consumption goods), the Chinese could lower their prices to offset a good part of the revaluation of their currency. In short, the competitive impact of China’s exports on US producers of equivalent goods might be far lower than US leaders are promising.
Fourth, if other nations across the developing world do not follow China and they keep their currencies from appreciating against the dollar, their assets become cheaper for China to purchase as well. Thus its global search for secure sources of energy and other raw materials would likely accelerate producing conflicts with other developed economies seeking such sources but without China’s advantages from the rising value of its currency. Chinese ownership of productive assets around the world would have all sorts of impacts on many developing countries as well.
Fifth, a rising relative value of the Chinese currency will to some extent raise the US-dollar prices of consumer goods and intermediate goods imported from China, thereby giving inflation inside the US a possibly quite significant push. This will damage the real incomes of US wage earners, provoke the Federal Reserve to raise interest rates, and provoke US workers to demand higher money wages — all events with many negative effects on the US economy.
Inside China, those producers (and their political allies) who stand to gain from raising the value of the Chinese currency (relative to the US dollar) are in an extended struggle with those who see more advantage in keeping the Chinese currency from rising. All sorts of internal Chinese economic, political, and cultural developments are continually altering the balance between the two sides in this struggle. Likewise, outside events — including pressure from US leaders — also affect that struggle and hence its outcome in terms of the movement of relative currency values. Internal and external changes combine to overdetermine the movement in the value of China’s currency. But were the extra pressure now generated by Treasury Secretary Paulson and Federal Reserve Chairman Bernanke during their Beijing visit to tip the balance and provoke a rise of the yuan, the results could well come back to haunt them, President Bush, and both political parties as an angry population suffers results like those listed above.
Rick Wolff is Professor of Economics at University of Massachusetts at Amherst. He is the author of many books and articles, including (with Stephen Resnick) Class Theory and History: Capitalism and Communism in the U.S.S.R. (Routledge, 2002) and (with Stephen Resnick) New Departures in Marxian Theory (Routledge, 2006). This article was adapted from an earlier version that Wolff published at www.globalmacroscope.com.
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